Gold exchange-traded funds (ETFs) allow investors to gain exposure to gold (and its performance) the same way they would any other ETF or company stock. Like any investment, there are pros and cons, but if utilized well, gold ETFs can play a role in your portfolio. Here are two reasons why a gold ETF may be good for your portfolio.
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1. It can help hedge against inflation
During times of inflation, consumer goods become more expensive, and the dollar's purchasing power drops. In February 2022 alone, inflation in the U.S. rose 7.9%, mostly caused by energy and food prices. Since gold is dollar-denominated -- meaning its underlying value is in dollar terms -- its price generally increases as inflation rises.
As inflation occurs, many investors tend to convert some of their cash holdings into gold to help protect their portfolio value. This increased demand for gold can set off a chain reaction that increases the price of gold even more. This is why gold has been historically viewed as an asset that can help offset periods of high inflation.
Unfortunately, the process of buying, transporting, and storing physical gold can be inconvenient and costly. Gold ETFs give you exposure to gold and its benefits without worrying about the logistics involved with physical gold.
2. Holding it in a retirement account can help you bypass potentially higher capital gains taxes
Commodities -- like precious metals, artwork, coins, stamps, antiques, and such -- are labeled as alternative assets by the IRS and face a higher maximum 28% long-term capital gains tax rate. Unlike ETFs that are subjected to your standard long-term capital gains rate, ETFs backed by precious metals like gold and silver also face this higher rate.
If you make $100,000 annually, your long-term capital gains rate would be 15%. So, if you purchased and sold a regular ETF for a $1,000 profit, you'd owe $150 in taxes. If it were a gold ETF, you'd pay either your ordinary income tax rate or 28%, whichever's less. That could increase your tax bill by up to $130. Luckily, you can offset these increased capital gains taxes by purchasing gold ETFs in a Roth IRA.
Because you contribute after-tax money into a Roth IRA, you won't have to pay any taxes whenever you make withdrawals in retirement. To see how much money you could save by purchasing a gold ETF in a Roth IRA versus a brokerage account, let's imagine you used dollar-cost averaging and accumulated $100,000 in profit in both accounts.
With a Roth IRA, as long you're 59 1/2 years old, you'd receive all $100,000 after selling the gold ETF and withdrawing the money. However, with the brokerage account, you would owe 28% on the $100,000, creating a $28,000 tax bill.
Multiple benefits in one
One of the key aspects of a good financial portfolio is diversification; you don't want too much of your retirement savings reliant on a few assets. Adding a gold ETF to your retirement portfolio is a great way to kill two birds with one stone by combating inflation and diversifying your portfolio. Gold ETFs can help put your portfolio in a position to thrive in the long term.
